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Yesterday, the Congressional Budget Office (CBO) released a brief on student loan interest rates. It’s a treasure trove of information, and it adds new information to the debate in Congress over how to set interest rates on student loans. Here are five key points from the report.

1.      The Government Won’t Make Money on Student Loans

Student advocates and left-leaning think tanks say that the federal government makes money on federal student loans and therefore Congress should cut interest rates. The CBO has repeatedly warned lawmakers that those figures are wildly out of whack and it reports them only because it has no choice – the law requires it. According to both the CBO and many financial economists, a more accurate measure would better account for risk that taxpayers bear in making the loans. From the latest CBO report:

FCRA accounting [the official rules] does not consider some costs borne by the government. In particular, it omits the risk taxpayers face because federal receipts from interest and principal payments on student loans tend to be low when economic and financial condition are poor and resources therefore are more valuable. Fair-value accounting methods account for such risk and, as a result, the program’s savings are less (or its costs are greater) under fair-value accounting than they are under FCRA’s rules. On a fair-value basis, CBO projects that the student loan program will yield $6 billion in savings in 2013 and will have a cost of $95 billion for the 2013–2023 period as a whole…

To be sure, on a fair-value basis the loans make money for the government – but only for the next three years. And that is a good argument for reducing rates on loans issued in those years. But then the loan program flips to a large cost of $13 billion per year, on average, starting in 2016, more than erasing any gains. Why the big change from gains to losses?  It’s because the government charges the same interest rate on student loans no matter what is happening to interest rates in the economy. As a result, when rates are low, the loan program generates small profits; when rates are higher, as they are projected to be in the near future, and the economy is doing better, it provides relatively larger subsidies to borrowers at a cost to the government.

2.      Current Interest Rates Poorly Target Benefits

The best way to fix what the CBO calls subsidy rate variation is to peg interest rates on student loans to interest rates in the market – though the rates can still be held below-market. Such a plan would keep the size of the subsidy provided to students relatively equivalent, rather than providing a much smaller subsidy to students in a struggling economy. It would also reduce or eliminate any profits the government makes in low-rate years. According to the CBO:

There would be less yearly variability in subsidy rates under options that linked student loan interest rates to market rates than there is under current law.

Senate Republicans have a proposal to do that. President Obama does, too. House Republicans are on board. But both Republican plans only partially peg loans to market rates because they would cap interest rates at 8.25 percent. (The Senate Republican plan has a "hidden" cap that borrowers can trigger when they consolidate their loans once they leave school.) Both plans fall short of stabilizing the size of the subsidy in that regard. From the CBO report:

Imposing interest rate caps would increase the yearly variation in subsidy rates relative to options without caps. If a cap is binding—as would occur when rates on Treasury notes are high—interest rates on loans would be lower and the loans would receive a higher subsidy than they would without a cap.

3.      Senator Warren, Call Your Office: You’ve Been Outspent

Here is another revealing point in the new paper. It includes a hidden estimate of the cost of Senator Jack Reed’s proposal to reduce interest rates on student loans such that the program generates no “profit” for the government. Look at the estimated costs of the program under current law as show on the last line of Table 5 (and remember, these are under Federal Credit Reform Act accounting, not fair-value, so they’re not showing the true costs of the program). It shows savings of $184 billion over 10 years. The Reed proposal would effectively set the number to zero, meaning his proposal would cost $184 billion. And that’s not even the entire cost. That figure is for newly issued loans only. The Reed proposal would also let borrowers with old loans “refinance” into the new, lower rates his plan would set. That could easily add $50 billion, or even $100 billion, to the $184 billion figure.

Senator Warren, call your office. Senator Reed has sponsored the most expensive and most generous student loan proposal in Congress. You’ve been outspent by hundreds of billions of dollars.

4.      Option to Lock in Rates is Valuable

The CBO paper makes an important point about a provision in the House-passed plan, which provides borrowers with variable rate loans while in school, but allows them to lock in a fixed interest rate at any point during repayment.

The option to convert variable-rate to fixed-rate loans is valuable for borrowers and costly to the government because borrowers tend to convert when they believe interest rates will increase in the future. By contrast, when all loans carry fixed rates, there is no such timing incentive for consolidation.

Critics of the House-passed plan seem to have completely missed this point, as have the media. Providing borrowers with variable rate loans and an indefinite option to lock in a fix rate is a big benefit, albeit one that requires much more financial literacy on the part of students and borrowers.

5.      Interest Cap or Pell Grant? Take Your Pick

Also on the issue of interest rate caps, the CBO shows how much it costs to add them to various proposals. Capping rates at 8.25 percent adds a cool $40 billion to the cost of the fixed rate plans, like the one the President proposed. That is nearly enough to stave off the benefit cuts scheduled for the Pell Grant program in the coming years. All of the advocates and policymakers who insist that any proposal must have a cap should consider this:

Would you rather spend $40 billion arbitrarily capping interest rates for low-, middle-, and high-income borrowers, or shoring up the Pell Grant program for low-income college students?

This post was updated on May 31 and June 3 with additional entries.

The White House and House Republicans are arguing over two competing proposals to reform how the government sets interest rates on federal student loans. As we wrote two weeks ago, this is a good sign and a big improvement over the debate on the exact same issue from a year ago.

But if you are scratching your head trying to understand how the House plan and the president’s plan are different, it is because they are in fact very similar. Both tie rates to the market. The president’s plan only offers borrowers fixed rates, but the rate offered changes every year. The House plan requires different rates on the same loan while the borrower is in school, but then gives them the option to elect a fixed rate, which, like the president’s plan, is different depending on the year. Under the House plan, borrowers wouldn’t know unless they consolidate their loans exactly how much they owe.

Unfortunately, incomplete and inaccurate information about the pending proposals abounds. Below is an incomplete list of such information along with additional facts to bring more clarity to the debate.

The New York Times:

The [House-passed] legislation would cut the deficit by $3.7 billion over 10 years, a small but politically significant number, since White House officials say the deficit should not be reduced on the backs of indebted college graduates.

The New Republic:

Obama (whose own proposal is designed to be budget neutral; no additional spending on, or revenue from, student loans)...

Key Details Missing:

According to the Congressional Budget Office, the White House’s proposal would reduce the deficit over 10 years by more than the House proposal. The official figure is $6.7 billion. Why is that the case? The CBO estimates that the White House proposal would charge borrowers higher interest rates overall than the Republican bill passed in the House. If you add in the cost of the president’s proposal to expand a more generous income-based repayment plan to more borrowers, his combined proposal still reduces the deficit by $3.1 billion over 10 years, about the same as the House plan. To address The New Republic, the president's plan does include new "revenue" from student loans.

The New York Times should have called the White House on this hypocritical charge. The New Republic's account is wrong and one-sided.

The Institute for College Access and Success:

To make matters worse, [under the House-passed bill] the rate on every loan will change each year… This means the monthly payments required under most plans will change each year as well.

Key Details Missing:

Interest rates on the loans under the House plan do in fact change once a year after issuance, but borrowers my lock that rate in at any point after they have left school. Under the House plan, borrowers always have the option to choose a fixed rate (a free option) over a floating rate at any point during repayment. The interest rate and payments on the loans will not change if borrowers elect a fixed rate. While in school, the loans will carry interest rates that change once per year.

Under the president’s plan, borrowers would be issued fixed rate loans, but each loan would carry a different interest rate each year. (We proposed something similar). The difference in rates depends on the year the student borrows. This year it could be 5 percent, and next year the newly-issued loan could carry a rate of 7 percent, or even 4 percent, depending on where market rates go.

David Hawkings of CQ Roll Call:

But the GOP bill being passed today takes the [president’s interest rate] idea a significant step further — so much further, in fact, that the Obama administration has threatened a veto. While the House measure would link the rate to T-bills, as Obama proposed, it would set a much higher cap than the president on the maximum interest rate: 8.5 percent. [Emphasis added]

Key Details Missing:

David Hawkins for some reason believes the White House is opposed to the House plan because the interest rate cap in the House plan is too high, higher than what the White House would support. But the president’s proposal has no cap! None whatsoever.  The House proposal, at least in that regard, is more generous to students than the president’s plan. [We Tweeted at David to alert him to the error last week, but no correction has been run.]

USA Today:

The House Republicans' proposal would tie loan rates to the interest rate on a 10-year Treasury note, plus 2.5%, with a cap that would prevent the interest rate on Stafford loans from rising above 8.5%. Obama's proposal would have set the rate at slightly less than 1% above the Treasury note rate.

Key Details Missing:

The president’s proposal would in fact set the mark-up over 10-year Treasury notes at 0.93, 2.93, and 3.93 percent for Subsidized and Unsubsidized Stafford and Grad/Parent PLUS loans, respectively. Therefore, the 0.93 mark up is true only for Subsidized Stafford loans. On the more widely available Unsubsidized Stafford loans, the mark-up is actually higher under the president’s plan than under the House plan. The House proposes a higher mark-up Grad/Parent Plus loans than the president.

In short, the mark-ups are different for each loan type. That is an important detail that USA Today glosses over in a way that paints the president’s plan as more generous when the truth is more complicated than that.

Rep. George Miller in the Detroit Free Press:

Democrats compare the plan to predatory adjustable rate mortgage practices that helped fuel the housing collapse during the financial crisis. “We just saw that history in America. We saw what they did,” said Rep. George Miller, D-Calif., the senior Democrat on the Education and Workforce Committee.

Economists and academics have roundly dismissed the claim that variable rate mortgages had anything to do with the housing crisis. In the words of several Federal Reserve economists, “the data are not kind” to that narrative. They show that variable interest rate and fixed interest rate mortgages defaulted at the same rates, and that borrowers who had variable rate mortgages were paying the same interest rate when they defaulted as when they took out the loan.

Rep. Miller says, "we saw what [the variable rate mortgages] did," but what he says they did is entirely unsupported by actual data or research. The claim should be left out of both the housing crisis debate and the student loan debate.

The New Republic:

Keep in mind that the current [interest] rate has already produced record levels of delinquincy--[sic] the Department of Education announced last week that 11 percent of loans were 90 days or more past due.

Key Details Missing:

The New Republic has invented a novel explanation for student loan delinquency. No credible source or research has linked the current interest rate on federal student loans to the record levels of past-due loans. Readers will notice that The New Republic article includes 13 different links to substantiate its statements of fact -- but not on this one. And good luck finding one. Everyone accepts  large loan balances, the economy, or high unemployment as possible causes, but interest rates?

Mother Jones:

The GOP plan also includes no provision capping monthly payments according to income level, as Obama's does.

Key Details Missing:

All outstanding and newly issued federal student loans include a provision capping borrowers monthly payments according to income level. A more generous version of that benefit applies to all newly-issued loan under the president's proposal and the House proposal -- the two proposals share the exact same income-based repayment benefits for new loans. That is because those benefits are standard benefits already in law. The president would change the law to add the more generous version of the benefit in place for new loans to loans not affected by the interest rate changes, generally loans made prior to 2007, and the House would not, though the less-generous income-based repayment cap still applies to all loans. In other words, the GOP plan includes no provision capping monthly payments because one already exists in current law.

The Debate Continues On

In the coming weeks, the Senate is likely to consider its own proposals for setting interest rates on student loans. That will add more options into the mix, and more confusion. But here is a shortcut to understanding the different proposals: The president’s plan, the House-passed plan, and a leading bill sponsored by Senate Republicans really aren’t all that different from one another. Maybe that’s why there is so much confusion. The plans differ in only nuanced and technical ways, not in the broad ideological terms that might otherwise clearly set them apart.

Last week, Republicans on the House Appropriations Committee circulated a proposal that would shift fiscal year 2014 funding from health care, job training, and education programs to military and national security programs. (Fiscal year 2014 starts October 1, 2013.) Just how big of a hit does that mean for education programs? Put it this way, the cuts the House Republicans have in mind for the upcoming fiscal year are four times larger than those under sequestration. That is, take education funding—already lower due to sequestration—and cut it again four times over.

Last month we explained in the issue brief, Federal Education Budget Update: Fiscal Year 2013 Recap and Fiscal Year 2014 Early Analysis, that House Republicans had big cuts to education programs in mind when they passed their budget resolution.

The Budget Control Act of 2011 limits fiscal year 2014 spending on appropriations (including most education programs) some $18 billion below the 2013 post-sequester level. House Republicans want to follow that limits, but they want to go a step further. They are proposing to increase funding for defense and national security programs while staying within that cap. That means everything else has to give.

The latest development, the release of the House 302(b) suballocations, provides the first look at what broad categories of programs will bear the brunt of the increase-defense-and-cut-the-rest policy that House Republicans are pursuing. The 302(b) suballocations are specified amounts that each appropriations subcommittee will be granted by the full House Appropriations Committee to design appropriations bills for the Department of Education and other federal agencies for the upcoming fiscal year.

Final appropriations in fiscal year 2012 for programs covered by the Labor-Health and Human Services (HHS)-Education Appropriations Subcommittee totaled $157 billion. In 2013, after the sequester, it is approximately $150 billion. Under the House proposal for 2014, the figure would fall to $122 billion.   

Democrats have expressed some concerns about the disproportionate cuts to social programs and welfare spending. And although the House Appropriations Committee has voted for the 302(b) suballocations and begun voting on defense spending bills, the Labor-HHS-Education 2014 spending bill would have to be approved both by the full House and Senate, so the cuts may never come to pass.

And there’s another reason the House Republicans are unlikely to succeed with their proposal: The last time Congress provided about $122 billion for the Labor-HHS-Education appropriations bill was in fiscal year 2002, without factoring in inflation. Do House Republicans really want to erase all of the funding gains for education made under the Obama administration and the Bush administration?

Still, as we warned in our budget brief last month, “an overall appropriations limit that conforms to the BCA and the House-passed budget resolution will almost certainly force spending reductions for some education programs.”  As the 2014 budget debate progresses through the halls of Congress, members will be considering whether or not they want to follow through with the reality created by a law they passed two years ago.

Be sure to check out this op-ed on Yahoo Finance regarding Senator Warren's proposal to cut interest rates on federal student loans.

This Ed Money Watch post has a rundown of all of the pending proposals, including the one sponsored by House Republicans that will be up for a vote next week.

Jason Delisle, the New America Foundation's higher-education maven, points out that there's still a lot more Congress and the White House have to fix. They could save billions, for example, by unifying the various loan terms the government offers to ...

Jason Delisle, the New America Foundation's higher-education maven, points out that there's still a lot more Congress and the White House have to fix. They could save billions, for example, by unifying the various loan terms the government offers to ...

The interest rates and fees are set high enough that the government makes money,” Federal Education Budget Project Director Jason Delisle said in a New York Times article published Feb. 27, “Putting a Number on Federal Education Spending.” The most ...

The White House “painted themselves into a corner” this year, said Jason Delisle, director of the Federal Education Budget Project at the New America Foundation, a public-policy think tank. The administration needed a plan to keep rates low without ...

The president’s fiscal year 2014 budget request includes a proposal for setting interest rates on newly issued federal student loans. Rates would be fixed for the life of the loan and set at a rate equal to the interest rate on 10-year Treasury notes, plus 2.93 percent for Unsubsidized Stafford loans, the most widely available federal student loan. (Subsidized Stafford loans would be set at the 10-year Treasury rate plus 0.93 percent, and PLUS loans for parents of undergraduates and for graduate students set at 10-year Treasury plus 3.93 percent.)  The rate would not be subject to a nominal cap. The approach is similar to one highlighted a year ago on this blog and again this year in the New America Foundation paper Rebalancing Resources and Incentives in Federal Student Aid.

The fact that the president excluded a cap in his proposal (as did the New America Foundation) has rankled student aid advocates (see here, here, and here). We’ve argued that the new income-based repayment (IBR) program that became available last year for students who began borrowing after October 1, 2007 ensures that a borrower’s monthly loan payments are capped – which therefore makes it a more generous benefit than an interest rate cap. Further, the program’s 10-year and 20-year loan forgiveness terms reduce, cap, or eliminate the interest that a borrower must actually pay, depending on the situation.

How does it do that? A borrower’s payments under IBR are based on his income, and the total time he is required to repay is limited through loan forgiveness, so there is a limit to how much he can ever pay on his loans -- and that limit can make the nominal interest rate on the loan or the amount borrowed irrelevant.

In a recent blog post, the Institute for College Access and Success (TICAS) offers an example in which a borrower pays more in total lifetime payments when the interest rate on the loan is higher. Is that inconsistent with the above statement? Not at all.

The borrower in the TICAS example has $20,000 in debt, has an Adjusted Gross Income of $30,000, and presumed household size of 1 (i.e. not married/married filing separately and no children claimed as dependents). Therefore, we can plot the interest rate cap that IBR would provide on her loans at various debt levels and based on whether she will have her debt forgiven after 10 or 20 years.

The Income-Based Repayment plan reduces and ultimately caps the borrower’s interest rate at 12.8 percent. After that point, any unpaid interest or principal balance on the loan will be forgiven due to the maximum term of 20 years under IBR. And if the borrower had $30,000 in debt, IBR caps the interest rate at a very low 3.6 percent. At $50,000 in debt, her interest rate is capped at 0.0 percent – given her income she won’t pay even as much as her initial loan balance, so her interest rate is irrelevant. Why the big differences in interest rate caps? Again, her total payments on her loan have a limit based on her income and the 20-year term of the loan -- so more debt must translate into a lower interest rate cap and lower debt results in a higher interest rate cap.

Now suppose the borrower with $20,000 in debt in the TICAS example works for a non-profit, thereby qualifying for public service loan forgiveness after 10 years of payments. With PSLF, IBR caps her interest rate at 0.9 percent. At $25,000 in debt the interest rate is effectively capped at 0.0 percent. These figures are so much lower than under the 20-year forgiveness becuase the total payments this borrower could ever make are much lower, all because the loan term cannot exceed 10 years.

And if the borrower has a child to declare in her household size, all of the numbers cited above are lower because the program increases the allowable income exemption for each dependent child in calculating the monthly payment. But rather than write out more examples, the table above is instructive. The information in the table is for a borrower who matches the income profile of the borrower in the TICAS example. We use the New America Foundation IBR calculator for all calculations. 

As the table above demonstrates, IBR provides very valuable benefits by reducing, capping or eliminating interest rates on federal loans. (However, the perverse incentives to borrow more and the windfall benefits for high-income high-debt borrowers, mainly graduate students should be addressed.) No doubt, a nominal interest rate cap written into law can provide even greater benefits for borrowers in certain circumstances. But is a cap necessary given the benefits of IBR and would it be worth the extra costs? Probably not, and the Obama Administration agrees.

This week’s podcast features Clare McCann, program associate with the Education Policy Program at New America, as well as Jason Delisle, director of the Federal Education Budget Project, discussing the president’s 2014 budget request.

... the plan would be $25 billion in the first five years and would save $15 billion over 10 years, according to Jason Delisle, director of the federal education budget project at the New America Foundation, a Washington-based nonprofit public-policy ...